The NASPP Blog

Last year, the Indian Ministry of Finance surprised us by changing the taxation of equity compensation income by introducing the Fringe Benefit Tax (FBT). Although the annual FBT return is due on October 31st, and the next advance payment installment must be made by December 15th, companies are still struggling with what FBT will mean for them.

The introduction of FBT on stock income abolished the use of tax favorable stock plans in India. All equity awards are now exempt from income tax to employees. Instead, the Ministry of Finance will tax the employer at 33.99% on the ‘value’ of the grants when they vest. I use quotation marks for the word value because the definition of the value of shares on the vest date is unique to India. Only companies that are publicly traded in India may use the market value to determine the gain at vest. All others, including U.S. public companies, must employ a qualified Category 1 Merchant Bank to determine the appropriate fair value. This valuation is good for 180 days; technically a company could obtain a valuation twice per year and satisfy the valuation requirements. This causes some issues with the value taxed vs. value received, especially for employees of companies that are passing the FBT cost on to participants.

Some U.S. companies have chosen to pass the FBT on to their employees. Recovering the FBT from employees creates some unique issues for the employer. Because this is an employer tax, the reimbursement of FBT creates what is essentially a variable strike price and actually decreases the expense valuation of the grant. Basically, the recovered FBT is added back to the award as if it were part of the exercise or purchase price. This means that the employee pays more for the grant, reducing the valuation. Companies should be using a Lattice or Monte Carlo valuation method for these awards. Note that this also means that option grants are more likely to be underwater in a way that your stock plan administration software may not be able to track. According to the Practical Solutions for Stock Plans in India session from our conference this year, we are seeing an even split between U.S. companies that are choosing to pass FBT on to employees for new grants vs. those who are not. Curiously, a gentleman attending the session said that most India companies are passing the cost on to employees.

Another troublesome feature of FBT is that it is charged to the India subsidiary, but does not qualify for a company tax deduction (likewise, the recovery of FBT from employees does not increase the company’s income). This means that if the company does not choose to recover the FBT from employees, it will directly reduce the income of the sub without any cost recovery. To compensate for this, some companies are choosing to reduce the size of grants to Indian employees (which would not help the sub directly if the company is not recharging the award cost). Another option is for employers to turn to a cash-settled incentive, which would not be subject to FBT.

Finally, there is the subject of the estimated FBT payments due by the company on June 15th (15% of estimated FBT), September 15th (45% of estimated FBT, reduced by any actual amounts paid ytd), December 15th (75% less any payments made), and March 15th (100%). These advance payments were a topic of bitter conversation at the convention. Advance payment is pretty straight-forward for restricted stock, especially because the fair value might only be determined twice per year. The more difficult estimate is the option exercises. Even though the value of the FBT is determined using the grant date, it is not payable until the exercise date using a first-in-first-out (FIFO) method. Listening to these conversations, the issue that stood out the most to me is the recovery of over-payment of FBT. Underpayment of advance payments is only subject to a simple 1% interest charge. Overpayment, however, is not recovered by reducing the next year’s payment, but rather by applying for a reimbursement (which could take a considerable amount of time). This means that many companies are taking a hard look at how they estimate those payment as the cost for overpayment is significantly higher than the cost for underpayment.

If you haven’t already, take a look at our India page in the Global Stock Plans portal. There are a number of alerts posted specifically about the FBT tax. Sign up to receive the latest alerts here. You may also find additional details in the India Country Guide by the Jones Day Associate Firm, P&A Law Offices. There have been quite a few questions about India FBT in our Discussion Forum. Don’t hesitate to bring yours up. We have a great team of top international plan experts who are ready to help!